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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Karin Technology Holdings Limited (SGX:K29) is currently trading at a trailing P/E of 14.3, which is higher than the industry average of 11.4. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
View our latest analysis for Karin Technology Holdings
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for K29
Price-Earnings Ratio = Price per share ÷ Earnings per share
K29 Price-Earnings Ratio = HK$1.87 ÷ HK$0.130 = 14.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to K29, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since K29’s P/E of 14.3 is higher than its industry peers (11.4), it means that investors are paying more for each dollar of K29’s earnings. This multiple is a median of profitable companies of 21 Electronic companies in SG including Willas-Array Electronics (Holdings), Ban Leong Technologies and Serial System. You could think of it like this: the market is pricing K29 as if it is a stronger company than the average of its industry group.
A few caveats
However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to K29. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Karin Technology Holdings Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to K29 may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.